I've been too busy to post about finance in a while...

[randomness]

...but this story is just a bit too good to let pass by. Apparently J.P. Morgan has somehow managed to lose at least a couple of billion dollars through some extremely questionable trades in the last few weeks.

From the FT's Alphaville blog:

In a conference call on Thursday night, CEO Jamie Dimon put mark-to-market losses at $2bn for the unit. Dimon has thus gone from calling the CIO’s trades a “a complete tempest in a teapot” to referring to the losses “plays right into the hands of a whole bunch of pundits out there”.

Other things Dimon said during the conference call:

“…Errors, sloppiness, and bad judgement.”

“Bad strategy, badly executed and poorly monitored”

“It could get worse. This could go on for a little bit.”

“Badly executed, badly monitored. I’m not going to repeat it 800 times”

“I know it was done with the intention to hedge tail risk… it was unbelievably ineffective”

Lisa Pollack of the FT has been covering the story for a few weeks now, ever since it became apparent that something funny was going on with JPMorgan's trades.

Today she appeared on Alphaville's daily Markets Live online chat, and gave this summary in answer to her colleague Bryce Elder's question, "Are we any clearer on what actually happened?"

Well... yes and no
There was never a huge amount of disclosure around the trades
There are, as best I know, three bits of evidence
Only one of which came from JPM
First two are in the market data
1. The index CDX.NA.IG.9 had a huge increase in the net notional amounts outstanding over the last half year
2. The skew blew out
Meaning that the index was way cheaper than the constituents.
From this we knew
That someone, or several someones, are pressuring the market in a particular way
Lots of selling pressure on the index, i.e. selling protection
3. JPM said the CIO had downside hedges on high grade credit
The CDX.NA.IG.9 is high grade credit
(for the most part)
But we just said that there was selling pressure, i.e. selling protection
These things don't compute
UNLESS it was a curve trade.
Where to are buying at one point and selling at another
The selling pressure at the long end of the curve can create the skew technical
And the bigger amount of buying you have to do at the short end of the curve can lead to the notional increase
It's a basic flattener trade
The thing about flatteners though
Is that you have to manage them quite actively
To get the ratio of buying to selling right
It looks like they were managing that...
... in fact they were managing that too much.
Hence the skew issue
The trades were too big for the market
They may have stopped managing the ratio even
Once they realised what they were doing
That the market didn't have enough depth
(And that pundits were having a ball)
(That it didn't look good)
But once you stop getting the ratio right
The trade starts to look a lot more risky
WAY more risky
That may be what we are seeing now
With their losses
They are finally having to admit
That they did this too big
And the market can't take it.

Bryce Elder's summing up for the audience:

I understood a lot of that. Thanks.
To be honest, the intricacies of synthetic flatteners and suchlike give me the yips.
But I do know about gambling.
I know that, when your system stops working, few resist the temptation to double down.
Because, when it starts working again, you cover your losses.
But systems can't do that.

I do like these stories.
They seem to prove that it's a mug's game applying statistical probability to a weighted selection of events.
It's not a faulty VAR model, it's a faulty assumption that you could ever quantify the actions of a crowd.
And a faulty belief that your trajectory of returns is anything other than random.

Comments

[bedfull-o-books.livejournal.com]

My company 401 K is managed by JPM. Shit.

[r-ness.livejournal.com]

Not to worry. This is the bank's own money they managed to lose.

[drwex]

yeah, they crapped the bed on their prop desk. Also, in large part due to the recently imposed regulation they are much more heavily capitalized than they were a couple years ago.

I expect eventual losses on this to top 3 bn and they can absorb that with internal cap reserves. I also expect most of their prop group is going to be out on the sidewalk in short order. Whether Dimon survives is wholly dependent on how much of a hit their stock takes in the next week or two. it's down about 8% at mid-day today.

It's a truism on Wall Street that risk migrates to the ends - the people who are stupid get stuck with risk they don't deserve and the people who are very smart take on risk they think they can handle. That's what seems to have happened here, but really when the entire Street can see that your ass is overexposed it's time to re-think how smart you really are. Bottom line I think they got greedy and upped their bets, which caused the market to move against them.

[r-ness.livejournal.com]

when the entire Street can see that your ass is overexposed it's time to re-think how smart you really are.

Seriously! They had the FT, Bloomberg, the Wall Street Journal, and Zero Hedge all writing stories about what was going on for weeks.

"Hello? Anyone home over there?"

[achinhibitor.livejournal.com]

Especially since once the players see you're overexposed, they can take advantage of you.

As we said in Iowa, "More balls than brains."

Which reminds me, I should start a consulting firm specifically to help rogue traders circumvent risk management. I expect it to be very profitable!

[ulfhirtha.livejournal.com]

Reminds me a touch of the Bank of England losses a few years back, largely due to one man.

[drwex]

This is nothing like that. It's not one rogue trader or whatever - it's a whole prop-trading group that got very deep into a complex strategy that (I think) they didn't really understand and didn't hedge properly against so when it moved against them they were caught out.

[ulfhirtha.livejournal.com]

No, not a rogue trader. More in that same vein of "you mean no one was watching this carefully? With billions on the line?" Especially after the disasters of the previous years in getting into things they didn't quite grok and getting it right in the rear.

[rednikki.livejournal.com]

I only understood enough to know that this is a BAD THING. But I didn't even know about this Bad Thing, so thanks for posting about it.

[r-ness.livejournal.com]

I think of it as more of a "point and laugh" thing, but then I own no JPMorgan shares. :)

[drwex]

r_ness is right. This is not a bad thing, this is a very good thing, at least for you and me. For once, the bank only blew up its own money and will have to eat its own losses (yay!). For another it's a way for the regulators to point and say "See, isn't it good we forced them to recapitalize?" (true, and also yay!)

And frankly, there's the vast schadenfreude of watching some smart-asses get a public drubbing that illustrates how they're not nearly as clever as they thought they were.

[r-ness.livejournal.com]

Absolutely. My schadenfreude level right now is extremely high.